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JP Morgan's 3rd Quarter Earnigns Analysis and a Chronological Reminder of Just How Wrong Brand Name Banks, Analysts, CEOs and Pundits Can Be ...

By: Reggie Middleton | Sunday, October 17, 2010

... When They Say XYZ Bank Can Never Go Out of Business!!!

Note:I will be on CNBC's
Squawk on the Street Monday Morning, Oct 18th to discuss my (probably
controversial) opinions on banking, technology and real estate. It should
be interesting for I believe I am a very "different" type of pundit. Be
sure to tune in and write CNBC with your opinions and comments.

Meredith
Whitney downgraded Bear Stearns today Friday, March 14th, 2008: "Yep,
she did it. The ratings agencies are considering a downgrade. I thought it
was a joke when I first heard it. Let's just imagine that I used these wise
sources as an info source to make my money! The ratings agencies and sell
sides are jokes that I can no longer laugh at."

It's a good thing no one listened to that damn blogger who has the gall
to charge money for his research and opinion. We had to listen to him bitch
and moan for 2 months before... Is
this the Breaking of the Bear? (January 2008)"

Bear Stearns is in Real trouble

Bear Stearns will soon be, if not already, in a fight for its life... the
biggest issues don't seem all that prevalent in the media though. Bear Stearns
is in a real financial bind due to the assets that it specialized in, and
it is not in it by itself, either. For some reason, the Street consistently
underestimates the severity of this real estate crash. If you look throughout my
blog, it appears as if I have an outstanding track record. I would love
to take the credit as superior intelligence, but the reality of the matter
is that I just respect the severity of the current housing downturn - something
that it appears many analysts, pundits, speculators, and investors have yet
to do with aplomb. With a primary value driver linked to the biggest drag
on the US economy for the last century or so, Bear Stearn's excessive reliance
on highly "modeled" and real asset/mortgage backed products in its portfolio
may potentially be its undoing. This is exacerbated significantly by leverage,
lack of transparency, and products that are relatively illiquid, even when
the mortgage days were good."

Notice how the worse case scenario is economic insolvency - as in less
than ZERO!

Book Value, Schmook Value - How Marking to Market Will Break the Bear's
Back

... I can say that when I do watch it I hear a lot of perma-bulls stating
that this and that stock is cheap because it is trading at or below its book
value. They then go on to quote the historical significance of this event,
yada, yada, yada. This is then picked up by a bunch of other individual investors,
media pundits and other "professionals," and it appears that rampant buying
ensues. I don't know how much of it is momentum trading versus actual investors
really believing they are buying on the fundamentals, but the buying pressure
is certainly there. They then lose their money as the stock they thought
was cheap, actually gets a lot cheaper, bringing their investment down the
crapper with it. What happened in this scenario? These investors bought accounting
numbers instead of true economic book value. Anything outside of simple widget
manufacturers are bound to have some twists and turns to ascertain actual
book value, actual marketable book value that is. This is what the investor
is interested in, the ECONOMIC market value of book, not what the accounting
ledger says. After all, you are paying economic dollars to buy this book
value in the market, so you want to be able to ascertain marketable book
value, I hope it sounds simplistic, because the premise behind it is quite
simple - How much is this stuff really worth?. The implementation may be
a different matter, though. I set out to ascertain the true book value of
Bear Stearns, and the following is the path that I took.

From the London
Business Times: Global stock markets may have cheered the US Federal
Reserve yesterday, but on Wall Street the Fed's unprecedented move to pump
$280 billion (£140 billion) into global markets was seen as a sure
sign that at least one financial institution was struggling to survive.
The name on most people's lips was Bear Stearns. [Hey, it pays to
read the boombustblog.com. ...] "The only reason the Fed would do
this is if they knew one or more of their primary dealers actually wasn't
flush with cash and needed funds in a hurry," Simon Maughan, an analyst
with MF Global in London, said. Bear Stearn's new CEO states unequivocally
that his balance sheet hasn't changed since November and that they have
$17 billion of cushion. [He did not outright say that they were
in good shape though. My concern was looking forward. They are a significant
counterparty risk (along with Morgan Stanley) and they have significant
illiquid level 2 and 3 assets as a percentage of tangible equity. In
addition, 17 billion is not much considering the leverage and amount of
illiquid assets held by this bank.]

And what happens after the fact? Yes, I can turn bullish as well...

Joe
Lewis on the Bear Stearns buyout Monday, March 17th, 2008: The problem
with the deal is that it is too low, and too favorable for Morgan. It is
literally guaranteed to drive angst from the other side. Whenever you do
a deal, you always make sure the other side gets to walk away with something.
If you don't you always risk the deal falling though unnecessarily. $2 is
a slap in the face to employees who have lost a life savings and have the
power to block the deal. At the very least, by the building at market price
and get the company for free!

Reggie Turns Bearish on Lehman in February, before anyone had a clue!!!

Web
chatter on Lehman Brothers Sunday, March 16th, 2008: It would appear
that Lehman's hedges are paying off for them. The have the most CMBS and
RMBS as a percent of tangible equity on the street following BSC. The question
is, "Can they monetize those hedges?" I'm curious to see how the
options on Lehman will be priced tomorrow. I really don't have enough.
Goes to show you how stingy I am. I bought them before Lehman was
on anybody's radar and I was still to cheap to gorge. Now, all of the alarms
have sounded and I'll have to pay up to participate or go in short. There
is too much attention focused on Lehman right now.

Like I said above, it's not as if upper management of these Wall Street banks
would ever mislead us, RIGHT????

Even if the big Wall Street banks would lie to us, we have expert analysts
at hot shot, white shoe firms such as Goldman Sachs, who of course not only
are "Doing God's Work" but also happen to be the smartest of the smart and
the "bestest" of the best, RIIIGHT!!!??? Below we have both Erin from Lehman
AND Goldman lying on TV in a single screen shot. Ain't a picture
worth a thousand words???

It
appears that I should have dug deeper into Lehman! May 2008: I never
got a chance to perform a full forensic analysis of Lehman, but did put a
fair size short on them a few months back due to their "smoke and mirrors" PR
(oops), I mean financial reporting. There were just too many inconsistencies,
and too much exposure. I was familiar with the game that some I banks play,
for I did get a chance to do a deep dive on Morgan Stanley, and did not like
what I found. As usual, I am significantly short those companies that I issue
negative reports on, MS and LEH included. I urge all who have an economic
interest in these companies to read through the PDF's below and my MS updated
report linked later on in this post. In January, it was worth reviewing "Is
this the Breaking of the Bear?", for just two months later we all know
what happened. I came
across this speech by David Eihorn and he has clearly delineated not
only all of the financial shenanigans that I mentioned in my blog, but a
few more as well. Very well articulated and researched.

So, who was right? The Ivy league, ivory tower boys doing God's work or
that blogger with the smart ass mouth from Brooklyn?

Note:I will be on CNBC's
Squawk on the Street Monday Morning, Oct 18th to discuss my (probably
controversial) opinions on banking, technology and real estate. It should
be interesting for I believe I am a very "different" type of pundit. Be
sure to tune in and write CNBC with your opinions and comments.

This is my opinion and analysis of JP Morgan's 3rd quarter 2010 operating
results. I have included the hefty sidebar to the right to give my readers
and subscribers historical perspective into the possibility of management being,,,
ah,, well, optimistic at times when confronting investors and the public about
what I see as potentially devastating macro and/or fundamental developments.
I also included the sidebar to illustrate and remind all that just because
certain big, brand name pundits, Wall Street banks and analysts may claim the
coast is clear and all is just fine, it may not necessarily be the case - particularly
when your favorite, most handsome and humble blogger claims otherwise. Please
take careful note of the dates next to each entry and video. The time line
aids significantly in giving the reader perspective. For those who are new
to BoomBustBlog or are not familiar with me and my work, please visit Who
is Reggie Middleton!!! before you move on.

As for those who may consider it blasphemous to mention the enshrined, the
exalted JP Morgan and Bear Stearns or Lehman in the same sentence - I query "Who
bought Bear Stearns?". Whatever Bear had, JPM now has - of course along with
some very convenient government guarantees. But, then again...

Cute graphic above, eh? There is plenty of this in the public preview.
When considering the staggering level of derivatives employed by JPM, it
is frightening to even consider the fact that the quality of JPM's derivative
exposure is even worse than Bear Stearns and Lehman's derivative portfolio
just prior to their fall. Total net derivative exposure rated below
BBB and below for JP Morgan currently stands at 35.4% while the same stood
at 17.0% for Bear Stearns (February 2008) and 9.2% for Lehman (May 2008).
We all know what happened to Bear Stearns and Lehman Brothers, don't we???

Now, on to JP Morgan's 3rd quarter 2010 results...

In a Nutshell, JPM's quarterly results were downright horrible - as we expected
and warned of in our previous quarterly analyses (see notes at bottom of page)...

JP Morgan's Q3 net revenue declined 11% y/y (-5% q/q) to $24.8bn as investment
banking revenue declined 18% y/y (-9% q/q) to $12.6bn from $13.9bn in the previous
year and net interest income declined 2% y/y (-2% q/q, off of a combination
of ZIRP victimization and a rapidly shrinking asset base and loan book) to
$12.5bn versus $12.7bn in the previous year. Non-interest expense increased
7% y/y (-2% q/q) to $14.4bn as compensation expenses to net revenues remained
broadly flat (28% vs 27.5%) while non-compensation expenses to net revenues
jumped to 33% vs 23% in the corresponding period last year. As a result of "Fraudclosure" we
expect this number to skyrocket next quarter. Overall, the efficiency ratio
(total expenses-to-net revenues) increased to 60% vs 51% and we expect this
ratio to spike next quarter as well as the banking business becomes even more
expensive.

As a result, banks allowances for loan losses have decreased to 4.9% in Q3
from 5.1% in Q2 and 4.7% in previous year. Although under provisioning has
helped the bank to mask its dearth in profits it has also materially undermined
its ability to absorb losses if economic conditions worsen. The Eyles test,
a measure of banks ability to absorb losses, has consequently worsened to 1.9%
in Q3 from 3.7% in Q2 and 5.9% in Q3 09.

I would like to note that I don't recall anyone making a big deal about this
topic when it first reared its head last year, although the trend was quite
obvious. Now, it is one of the biggest issues of discussion in the earnings
call Q&A. Was it potentially my advice on watching the spike in the repurchase
requests? I do hope somebody was paying attention!

If you haven't noticed, despite the fact JPM is pulling provisions to, IMO,
pad accounting earnings ahead of what I feel to be a tsunami of macro and fundamental
issues, they are at the same time going to the capital markets for a re-up,
and willing to pay a premium to do so...

JP Morgan has increased its reserves with regards to repurchase of sold
securities but the information surround these actions are very limited
as the company does not separately report the repurchase reserves created
to meet contingencies. However, the Company's income from mortgage servicing
was severely impacted by increase in repurchase reserves. Mortgage production
revenue was negative $192 million against negative $70 million in 3Q09
and positive $62 million in 4Q08."

Counterparties who are accruing losses from bad loans, (ex. monoline
insurers such as Ambac and MBIA, see A Super Scary Halloween Tale of 104
Basis Points Pt I & II, by Reggie Middleton circa November 2007,) are
stepping up their aggression in pushing loans that appear to breach certain
warranties or smack of fraud. I expect this activity to pick up significantly,
and those banks that made significant use of brokers and third parties
to place mortgages will be at material risk - much more so than the primarily
direct writers. I'll give you two guesses at which two banks are suspect.
If you need a hint, take a look at who is increasing reserves for repurchases!
JP Morgan and their not so profitable acquisition, WaMu!

Now, let's fast forward to the Q3 2010 conference call:

On outlook, what we said is for 2010 I think our outlook was plus or
minus $1.2 billion of expense. Obviously you'll take a look at our third
quarter numbers are a little higher. And so we're likely to come in at
the high end of that range. For 2011 what we've said is $1 billion of realized
repurchase losses. And what we've done is we've taken,based on what
we know, we've gone back and increased our reserves by $1 billion based
on the higher file requests as well as higher settlement demands. And
where we are today we believe we're adequately reserved based on what we
know and we'll go back periodically and review that.

Reggie Middleton (not invited nor present at the conference call, but throwing
his 22 cents (2 cents levered 11x) in anyway: But why are you raising
these reserves "based on the higher file requests as well as higher
settlement demands" now when it was obvious this was coming down
the pike anyway? Hey, I called it in Q4 of last year, and I have much, much
less access to info than you guys. It seriously looks as if you were more
interested in padding the quarter than in preparing for this issue - although
I could always be wrong. Is next quarter gonna be an "unexpected jump" in "higher
file requests as well as higher settlement demands" as well or
are you guys gonna come clean and realize that the insurers, investors and
borrowers are officially lawyered up and comin' after 'ya? Again, if you
haven't read it, peruseThe
Robo-Signing Mess Is Just the Tip of the Iceberg, Mortgage Putbacks Will
Be the Harbinger of the Collapse of Big Banks that Will Dwarf 2008! in
its entirety!

Oh well, back to the people who were invited, welcome, and present at the
conference call...

Matt O'Connor - Deutsche Bank

I realize you guys don't want to talk in too much detail on the litigation
reserve, but just conceptually, you've taken a little bit greater than
$4 billion reserves for litigation so far this year and I guess a lot of
us are just having a hard time understanding what it might be for and are
you getting ahead of it or are still trying to catch up and -

Jamie Dimon

You know our society, right? You know how many lawsuits go on, and class
action suits, and stock drop suits, and [unintelligible] suits and WaMu
suits and Morgan suits and it ain't going away. It's becoming a cost of
doing business.

...In repurchase reserves and litigation, it's unclear exactly how or
where it's going to show up, but we do think there will be some of that.
And when we make the statement that some of these costs may go on for a
while it relates also to that. That while we're burning through the vintages
or the GSEs there are other vintages where there may have been more of
a time lag than that. And I think it's also important to note that they're
fundamentally different, because a lot of the private label stuff didn't
have the same rules, requirements, disclosures. So they're all different,
but loan by loan it's going to have some of the same characteristics that
people are right. You're going to have to make them [unintelligible]. Hopefully
if they're going to sue just to win they're making a huge mistake.

Jim Mitchell

Right, but you're already contemplating some of those issues in your
current reserving?

Jamie Dimon

To the extent we can, you know? Reserves are - you can't guess and put
up numbers, but to the extent we can. I think the question is, between
the reserves we have is how long losses relating to repurchase, whether
it's GSE or private label, and whether it shows up on the litigation or
repurchase, how long they go on for. We don't expect it to be a blowup
kind of number. We expect it will be they'll just drag out these losses
as these things play themselves out.

Nancy Bush - NAB Research

Two questions. The first related to the foreclosure issues, and whether
there are going to be any extraordinary expenses associated with that.
And is the level of expense in that whole activity now going to be higher
going forward?

Jamie Dimon

I think I already mentioned that the way I look at it we're bearing $5
billion of charge-offs a year, $1 billion in repurchase reserves a year,
a lot of re-owned foreclosure, which I forget off hand, but it's big numbers.
Those numbers may bounce up and down and probably will go up a little bit
because of this, but I'm not sure they're going to materially change because
of this. And there will be litigation, I put to the side, I don't know
how it's all going to be sorted out.

... I think the way you should look at this topic is that we're bearing
today $7 billion of charge-offs, foreclosure, repurchase costs - this affects
reserves. That $7 billion will go up or down based upon the economy and
stuff like this. I'm not sure stuff like this is going to dramatically
change that number. It may extend it a little bit longer and stuff like
that but - and remember we have in total, between repurchase reserves and
the $11 billion, we have $14 billion of reserves for repurchases or loan
losses. And look, the mortgage thing is - we're halfway through all this.
We think we should continue and get done and make sure we do the right
things for the consumers, the investors, and the country. And so obviously
it will increase our costs a little bit and maybe we'll have to pay penalties
eventually to some of the AGs, but we really think we should just continue.

...And the big one is the $200 billion runoff of stuff, a lot of which
was acquired from WaMu. That will be running off for years.

I will be releasing the balance of this review to subscribers, including an
updated valuation, more on the (by now probably fully disintegrated) discount
on the WaMu purchase and any other issues we uncover.

As a matter of fact, the quarter ended before the "robo signing" scandal really
started making waves, thus the numbers reported are only the tip of the iceberg.
We contend that the "robo-signing' subject will actually open the door to a
much more critical issue for the banks (refer to our upcoming Foreclosure Crisis subscriber
research for details) as RMBS securities tied to residential mortgages
will experience higher loss due to longer liquidation time lines, negative
ratings and potential losses arising from the repurchase of loans from GSE's
due to mortgages not meeting the investor underwriting standards - or put more
directly, fraud during the underwriting process will come to the forefront
and cause many an investor to attempt to disgorge these loans and derivative
loan products. With GSE's already vying for more repurchases of troubled securities,
the outrage caused from falsified documents would further escalate the repurchase
demands. When combined with the issues of foreclosures, weakening pricing,
and legal issues with foreclosures which materially exacerbate the economic
sales and pricing situation, combined with the deluge of repurchase demands,
the banks will be facing one of the toughest periods of this century.

Let's not forget about CRE!

JP Morgan's (like many other banks) real estate related issues are woefully
underestimated, yet JP Morgan can get away with under-provisioning without
being punished by the markets. Hmmm!!! How long will that last?

Even visitors from Amsterdam, never having been here (area in the video below)
before, can see there is something fundamentally wrong with the mortgage landscape
(still) in many parts of the US. The clincher, "But how do all of these
people [developers] get all of this money to put up all of these [empty] buildings? [as
they are still building new buildings around the empty buildings that they
cannot sell or rent!]" I reply, "Those people over there! The banks!" As
I point to the local JP Morgan Chase branch in downtown Brooklyn.

The clip above is from the October 4, 2010 VPRO Backlight (Dutch public television)
featuring the issues facing JP Morgan, as well as the European banking sector.
This special was very well done and I look forward to the US public television
stations doing similar investigative work. See the
entire video (43 minutes) on the VPRO site (in Italian, Dutch and some
English with Dutch Subtitles).

Well, I fancy myself the personification of the free thinking
maverick, the ultimate non-conformist as it applies to investment and analysis.
I am definitively outside the box - not your typical or stereotypical Wall
Street investor. I work out of my home, not a Manhattan office. I build my
own technology and perform my own research - in lieu of buying it or following
the crowd. I create and follow my own macro strategies and am by definition,
a contrarian to the nth degree.

Since I use my research as a tool for my own investing
to actually put food on my table, I can stand behind it as doing what it is
supposed too - educate, illustrate and elucidate. I do not sell advice, I am
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Wall Street. This allows me freedom to do things that many can not. For instance,
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regardless of price. No conflicts of interest, no corporate politics, no special
favors. Just the hard truth as I have found it - and believe me, my team and
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